Commentary

Facebook sales growth is lumpy and slowing

Commentary: There’s a reason the company wants to go public soon

By

JohnShinal

SAN FRANCISCO (MarketWatch) — A novice investor poring through Facebook Inc.’s latest regulatory filing might have a tough time uncovering why the social-networking giant is conducting an initial public offering. A company with almost $4 billion in cash and $205 million in quarterly net income clearly doesn’t need the money.

Yet if the reasons behind the IPO seem a bit fuzzy, the timing is not.

A careful reading of Facebook’s
FB, +0.65%
amended S-1 makes clear why it wants to come out of the gate sometime in the next two months: its online-advertising business is highly seasonal, and the second quarter is a high season.

So unlike the company’s latest results, which underwhelmed some Facebook watchers, we can expect its first earnings report as a public company to be a strong one that will help goose the stock, once it starts trading.

At the same time, Facebook’s year-over-year revenue growth has slowed dramatically over the past year, decelerating to 45% from 107% in just three quarters. (See adjacent chart.)

The Menlo Park, Calif.-based social network is widely expected to price its offering in May. The simple reason it’s raising the money, of course, is because it can. Investor demand is likely to make it one of the largest tech issues of all time.

Yet some investors expressed disappointment earlier this week when Facebook released first-quarter results that showed a sequential dip in quarterly revenue and a year-over-year drop in net income. Read about Facebook’s latest results.

While the profit slide caused by a surge in marketing spending rightfully raised concerns, any investors caught off guard by the revenue trends haven’t been paying attention.

A lumpy business

Facebook’s results over the last two years show a consistent pattern: Advertising revenue surges in the second and fourth quarters, respectively, yet slows or even weakens in the first and third calendar periods.

In 2011, for example, advertising revenue surged more than 18% in the fourth quarter compared with the third, and likewise rose almost 22% in the second period compared with the first.

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In the third quarter of last year, by contrast, advertising revenue ticked up just 2.8%, while first-quarter revenue fell 2.7% from the previous quarter.

During the most recent period, ad revenue dropped 8.1% sequentially, the worst slowdown for the business in at least two years.

Because advertising sales make up almost all of Facebook’s revenue, the dip caused total first-quarter revenue to fall 6.5% from the prior period.

All of this means investors should expect Facebook’s revenue growth to be what Wall Street analysts like to call “lumpy.” That, in turn, could lead to seasonal volatility in its share price.

Year-over-year trends are mixed

While sequential numbers are of interest to short-term momentum traders, long-term investors should be more concerned with year-over-year growth figures.

By that measure, Facebook’s revenue trajectory is also cause for concern.

In the last four quarters, beginning with the second quarter of 2011, the company has posted year-over-year revenue growth of 107%, 104%, 55% and 45%, respectively. Those are total revenue figures. The figures for ad revenue, meanwhile, paint a similar picture, with corresponding growth rates of 83%, 44%, 44% (again) and 37%.

Posting 45% top-line growth sounds impressive when you consider that Facebook is now generating more than $1 billion in quarterly revenue. Still, investors shouldn’t ignore the obvious trend: The year-over-year revenue growth in the first quarter was less than half of what it was just nine months earlier.

If Facebook’s stock already was trading publicly, I likely would have led this column with that last bit of news. But as of today no one, apart perhaps from the company’s investment bankers and top executives, knows where the IPO shares will price.

Until the offering does price, it’s impossible to say whether investors who buy those shares are overpaying for the company’s growth. Once the market puts a valuation on Facebook, I’ll revisit the issue in detail.

For the time being, here’s one way to gage the potential frothiness of Facebook’s valuation. In its latest filing, the company pegged the value of its stock price, as of Jan. 31, at $30.89 a share for internal accounting purposes.

Because Facebook earned fully diluted net income (applicable to common shareholders) of 46 cents a share in 2011, that valuation equates to a price-to-earnings ratio of 67 times trailing-year earnings.

By comparison, Google Inc.
GOOG, +1.66%
— which many consider to be Facebook’s biggest rival, and which last year posted revenue growth of 29% and net income growth of 14% — ended Wednesday’s trading valued at 20.5 times trailing-year earnings.

To justify its much-higher P/E, Facebook needs to be posting and forecasting better growth numbers than that.

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